Kremlin Partnership Places BP at Risk in Russia Crisis

By Stephen Bierman and Nidaa Bakhsh -
Mar 25, 2014

No business has as much at stake as BP Plc (BP/), as the crisis in the West’s relations with Russia escalates.

The British oil company, whose shares are down 6 percent since Putin deployed troops in Crimea, holds the single biggest foreign investment in Russia -- a 20 percent stake in OAO Rosneft (ROSN) it acquired last year. U.S. sanctions last week against oil-trading billionaire Gennady Timchenko showed willingness to target Russia’s most important industry and Vladimir Putin’s closest associates.

That’s a concern for BP because Rosneft links it directly to Putin’s regime: the state owns 70 percent of Russia’s largest oil producer and it’s run by Igor Sechin, a confidant of Putin for two decades. While current sanctions won’t harm BP’s ability to do business in Russia, analysts said they worry about the long-term prospects for the Rosneft investment against a background of worsening relations between the West and Moscow.

“Tight sanctions would impact BP more than peers given Russia is their second-largest contributor to earnings and production after the U.S.,” said Brian Youngberg, an analyst at Edward Jones in St. Louis. “BP’s placed a big bet on Russia and something like this shows the risk in doing so.”

Since the start of the month, BP’s shares have dropped more than any of the 30 members of the Dow Jones Oil & Gas Titans index apart from Russian gas exporter OAO Gazprom. (OGZD)

Ukrainian Crisis

On a March 4 conference call, one day after the value of London-based BP’s deal tumbled $850 million as investors sold Russian stocks in response to the Ukrainian crisis, Chief Executive Officer Bob Dudley summed up the importance of Rosneft for a company still trying to recover from 2010’s Gulf of Mexico disaster.

“And then there is our unique investment in Russia’s growing energy industry,” he said. “Russia is, of course, one of the world’s largest oil and gas producers and a country where BP has a long and successful track record. Through our investment in Rosneft, we have created a unique position.”

While the company is monitoring the situation, it remains fully committed to its investment in Russia, said Toby Odone, a BP spokesman. Rosneft declined to comment.

The investment in Rosneft, where Dudley sits alongside Sechin on the board, accounts for almost a third of BP’s production volume and 13 percent of net income, according to analysts at Deutsche Bank AG.

It also brings BP a position in Rosneft’s exploration projects with other international oil producers, including a venture with Exxon Mobil Corp. to drill a multibillion-barrel prospect in Russia’s Arctic Ocean.

Further Sanctions

The risk is that the U.S. and Europe decide to tighten sanctions further should Russia make further incursions into Ukrainian territory.

“Investors are worried of a repeat of what we saw with Iran sanctions when the U.S. blocked foreign companies from working in the U.S. if they had any links with Iran,” said Chris Weafer, a partner at Macro Advisory in Moscow. “BP is by the far the most exposed of all the international majors because of its equity stake in Rosneft.”

While those types of broad-ranging sanctions are a worst-case scenario, Sechin is a possible target in the near term given the strength of his relationship with Putin. He worked with Putin in St. Petersburg in the 1990s and was deputy prime minister before being given charge of Rosneft.

Individual Sanctions

While individual sanctions on Sechin wouldn’t affect Rosneft directly since he owns only 0.1 percent of the company’s stock, as long as he stayed at the helm BP and Dudley could pay a reputational cost for continuing the relationship. And as Total SA (FP) found last week, sanctions on individuals can decimate the share price of a company.

Shares in Novatek plunged as much as 13 percent in Moscow on March 21, the day after sanctions were announced, on concern U.S. action against Timchenko will harm the company’s prospects. That cut the value of Total’s investment by about $1 billion.

A Total spokesman decline to comment on the sanctions and their impact on Novatek.

Ultimately, Rosneft’s sheer scale and importance to worldwide energy supply may protect it from sanctions.

Global Production

Through a series of deals, Sechin made Rosneft the world’s biggest publicly traded crude oil company by production, pumping about 4.2 million barrels a day, or almost 5 percent of global output. BP gained its shareholding as part of a $27 billion cash-and-share deal completed a year ago where Rosneft bought BP’s half of Russia’s third-largest producer, TNK-BP.

“Rosneft and BP are mutually dependent,” said Vadim Bit-Avragim, who manages about $4.1 billion at Kapital Asset Management in Moscow and doesn’t own Rosneft shares. “Sanctions don’t concern these players. What’s more, when they entered Russia, they understood all the political risks.”

BP’s Russian investments have a rocky history in which TNK played a role.

In 2008, for example, the partners got bogged down in a protracted fight over whether dividends ought to be reinvested. TNK-BK’s Russian billionaire partners wanted to keep the cash flowing -- BP itself had gotten about $19 billion in dividends since the inception of the deal -- while BP argued it made more sense to slash dividends and plow money into new fields and equipment.

Forced to Leave

The rancor was such that then TNK-BP CEO Dudley was forced to leave Russia. BP accused the Russians of wanting to “tear up the agreement they had willingly signed.”

A few years later, the billionaires were irked that BP had been pursuing other deals in Russia without running them through TNK-BP. That squabble was settled with the 2012 sale to Rosneft.

For BP and Total, the hope will be that their investments will outlast the current turmoil in Russia’s relations with the rest of the world.

“It’s very unlikely that they will change their long-term strategy on the back of some geopolitical events,” said Jonathan Waghorn, a fund manager at Guinness Atkinson Asset Management Ltd. in London. “This is an example of the risks in the country.”